And the picture is not pretty. They have been on a steady decline since early May and still show little sign of rebounding. Ironically, the Chinese media and webosphere also tend to narrowly focus on the broad indices, adding to an ever-increasingly gloomy sense of doom.

But if one looks beyond the broad indices, a very different picture emerges. The blue chips, roughly represented by the Shanghai 50 Index, have shown remarkable resilience in the last three months (see chart below).

Some sectors, such as real estate and banking, have performed well. The real culprits of decline are generally the small-caps, liquor and food.

1. The stock market has been used as the easy way for founders and early investors to cash out. Absolutely nothing wrong on this aspect, if not for the fact that it's been plagued by various scams, such as faking data and senior management setting up their own private entities to siphon money from their public companies.

Such scams have reached hysterical levels since 2009, fueled by easy money from panic stimulus and the ultra-easy policy of China Securities Regulatory Committee, the Chinese equivalent of the SEC except being an even more incompetent joke of a regulator.

These junk stocks are gradually being outed in the market. This is very healthy self-correction and cleansing, as domestic investors gradually wake up from the delusion of blind profit due to absurdly high correlation in the perpetual bull market of yesteryears.

I expect a wave of delisting over the course of next few years. Good riddance.

2. The economic slowdown and bear market of the past seven months have shown many healthy effects of exposing the ugly and the evil. A big part of the ugly and evil is the dismal safety record of the food industry. They have been slaughtered, as long deserved.

The latest scandal is the discovery of above-allowance concentration of plasticizers in hard liquor. It will be a long time before the made-in-China brand earns any respect; but at least domestic consumers are finally getting fed up.

3. There are many signs of real estate stabilizing. And it's clear now that the government prefers a stable real estate market, as opposed to maintaining the bubble or busting it.

The policy intention has gained credibility, at least for now. The real estate bubble in China is real. But it is decidedly not like those in the U.S. and Europe because lending standards have been relatively stringent, with down payments of greater than 20% and since June greater than 30% required in Beijing.

Furthermore, there's no securitization that enables hard-to-track risk spreading and leveraging. It is an isolated problem, not a systemic trigger.

4. Chinese banks have plenty of dirty laundry, especially since the economic slowdown. But, again, the problem is of a different nature and magnitude than in the developed world. The financial derivatives business is not nearly big enough to cause hidden leverage and trigger chain reaction. Banks still get to enjoy state protection and cheap financing from low rates and ample savings.

5. The financial trust sector, however, is another story, and some banks that treaded carelessly into the shadowy place will pay. For example, Hua Xia Bank recently caused a stir because a trust product they sell has gone bust, as widely reported in Chinese media, and investors have taken to the street of a Shanghai branch.

Financial trusts are almost overtly a Ponzi scheme, reaching desperation level as some trusts are lowering the threshold to 200,000 yuan (about $30,000). It's only a matter of time the Ponzi game ends, and I suspect sooner rather than later. It will be ugly, but again I don't see the channel for this to become a systemic crisis.

6. Foreign money continues its 12-week net inflow into China, as reported by cnstock.com (in Chinese). Ironically, Chinese investors have consistently been the dumb money in their own home turf, many institutional investors included. Investor maturity is still in its infant stage; herd mentality and gambling behavior reign supreme as everybody tries to get ahead with purported inside information.

I suspect this time will be no different; foreign institutions, armed with their vastly superior experience, research, due diligence and risk management, will once again lead the trend.

Furthermore, while the new leadership in Beijing has hardly begun making its mark, it is at least encouraging that they haven't panicked. In fact their near apathy toward the strengthening yuan this year has been nothing short of remarkable. This is in stark contrast to the panic reaction of the outgoing leadership in 2009.

My guess is that they see the sociopolitical danger of inflation and want to tread prudently. Significant USD/CNY intervention is unlikely, since such actions are inherently inflationary. This is good news for CNY longs -- WisdomTree Dreyfus Chinese Yuan ETF ( CYB) -- and the reason why iShares FTSE China ETF ( FXI) has dramatically outperformed the Shanghai Composite Index and will likely remain so for awhile.

This could be an important transition period for China on many aspects, without counting too much (hopefully) on the new leadership. The sector rotation and weeding process in the Chinese stock market will bring it closer to a functional market. The yuan is inching toward a traded currency. The people are actually demanding non-poisonous food. Bankruptcy and default may even be allowed to happen soon.